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Thoughts from Joe - August 2, 2013

Top Eight

Job growth falters even as the unemployment rate continues to fall. The economy added a below-trend 162,000 jobs in July and the unemployment rate dropped to 7.4 percent. We still have 2 million fewer workers than January 2008 and labor force participation has fallen to levels not seen since 1979. Nonetheless, the Fed has been focused on one measure of employment: the unemployment rate. Will they admit using one statistic is a flawed approach or will they blindly agree the jobs market has recovered even though there are fewer workers and a larger population? Time will tell.

Growth in GDP surprises, but may be borrowing from the future. Gross Domestic Product rose 1.7 percent in the second quarter vs. expectations of just 1.0 percent. Much of the surprise came from unexpected inventory building which will have to be burned off in the future. Even without that caveat, sub-2 percent growth is dismal.

New method of funding the mortgage market falls flat. Freddie Mac's attempt to sell $500 million of "risk-sharing" bonds failed to gain significant interest from banks and insurance companies - the typical target market for mortgage offerings. The government is experimenting with a new way of funding the mortgage market that forces private investors to take the first loss and severely limits any upside participation. Unfortunately, the government is also enforcing punitive measures on regulated entities who invest in securities where risk is possible. Today's economic malaise stems from a total failing of the mortgage market and while I applaud the government's effort (beginning six years later) to fix it, this will be a very long road. The question we must answer is simply: What type of home borrower do we want to subsidize and how do we want to provide that subsidy. Unfortunately, the answers will not come so easy.

Federal Reserve Chairman may testify in a case regarding the bailout of AIG. A federal claims judge ruled Bernanke must testify as a "key decision maker" regarding the bailout. Should Bernanke's testimony play a pivotal role in determining the legality of the government's actions - as it surely will - and the verdict find the government at fault - as it very well may - the precedent will be set for a multitude of lawsuits waiting in the wings. However, such a deposition will have to survive many appeals and is likely far off into the future.

A District Court Ejects the Fed's Rule on Debit Card Fees. The 2011 rule enacted under Dodd-Frank was intended to reduce profits earned by banks on transactions. Dodd-Frank's directive was to ensure interchange fees reflect the actual cost of processing transactions. The rule set fees much too high according to the judge. So, Congress passes a law stating fees should be set so that no profit is earned. A government agency then sets a cap on the fees in question. And now a Federal judge deems that cap as too high. Today's innovation economy continuously finds ways to improve efficiency in search of profit. If the government continues down the course of outlawing profits, what sort of economy will remain?

President Obama proposes cutting corporate taxes as long as spending does not decrease. The President said, "If we're going to give business a better deal, we're going to give workers a better deal, too." It's false to say we are giving businesses a "better deal" by normalizing the tax structure. Businesses maximize outcome under existing circumstances. If you take 30 percent of cash that would be repatriated and invested, businesses will instead invest that money overseas, creating jobs for non-Americans. Encouraging cash to come back on-shore to be reinvested in the U.S. economy seems like the best deal around for the middle class.

The Fed took a more supportive tone in July's FOMC meeting, but indicated no real policy shift. The FOMC downgraded the economy slightly saying it expanded at a "modest" pace rather than a "moderate" pace and also expressed some concern over higher mortgage rates. So the Fed hints at pulling back QE and interest rates rise 100 basis points. In order to prevent further increases, the Fed has reversed its rhetoric, but the cat is out of the bag: they are concerned about running QEternity and are looking for an exit.

Economist at the Richmond Fed urges Europe to initiate QE. In a paper released last month, the economist stated "The ECB lacks a coherent strategy for creating the monetary base" and calls on the bank to buy "packages of government debt" and small business loans. So, this exact strategy is not working in the US, but a senior economist at a member bank of the Fed is encouraging foreign governments to follow suit. Bernanke wanted "transparency" and with transparency, you get a multitude of views. Though it may be controversial to say post the Snowden affair, too much transparency can be a bad thing.

Featured Item

SVB Asset Management Observation Deck: Steady Eddy Market speculation on the timing of the Fed's tapering has caused volatility in the bond market. Global corporate new bond issuance declined materially in June compared to robust issuance levels during the first five months of the year. Nonetheless, we generally expect corporate credit risk to remain steady through 2013 with a divergence in credit trends among various sectors.

Key Markets

Return

8/2/2013

1 week

YTD

Treasury

8/2/2013

7/26/2013

Change

Dow

15,658

0.6%

19.5%

30yr

3.69%

3.62%

0.07%

S&P 500

1,710

1.1%

19.9%

10yr

2.60%

2.56%

0.04%

Nasdaq

3,690

2.1%

22.2%

5yr

1.36%

1.37%

-0.01%

Euro Stoxx

2,811

2.5%

6.6%

2yr

0.30%

0.32%

-0.02%

Nikkei

14,466

2.4%

39.2%

1yr

0.10%

0.11%

-0.01%

Hang Seng

22,191

1.0%

-2.1%

3mo

0.02%

0.02%

0.00%

Source: Bloomberg

Looking Ahead

Next week does not include much on the data front, however I'll be watching Fed speakers for confirmation of tapering beginning at the September 18 FOMC meeting.

Earnings next week include:

Tuesday: Nuance Communications, First Solar Inc., Isis Pharma, Zillow

Wednesday: Ariad Pharma, AOL, Gogo Inc., Fusion-io Inc., Groupon

Thursday: NVIDIA, Onyx Pharma, Alnylam Pharma

The IPO calendar for next week includes YuMe, Cvent, and Intrexon.

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or SVB Asset Management, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.

SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value.

Top EightJob growth falters even as the unemployment rate continues to fall. The economy added a below-trend 162,000 jobs in July and the unemployment rate dropped to 7.4 percent. We still have 2 million fewer workers than January 2008 and labor force participation has fallen to levels not seen since 1979. Nonetheless, the Fed has been focused on one measure of employment: the unemployment rate. Will they admit using one statistic is a flawed approach or will they blindly agree the jobs market has recovered even though there are fewer workers and a larger population? Time will tell.Growth in GDP surprises, but may be borrowing from the future. Gross Domestic Product rose 1.7 percent in the second quarter vs. expectations of just 1.0 percent. Much of the surprise came from unexpected inventory building which will have to be burned off in the future. Even without that caveat, sub-2 percent growth is dismal.New method of funding the mortgage market falls flat. Freddie Mac's attempt to sell $500 million of "risk-sharing" bonds failed to gain significant interest from banks and insurance companies - the typical target market for mortgage offerings. The government is experimenting with a new way of funding the mortgage market that forces private investors to take the first loss and severely limits any upside participation. Unfortunately, the government is also enforcing punitive measures on regulated entities who invest in securities where risk is possible. Today's economic malaise stems from a total failing of the mortgage market and while I applaud the government's effort (beginning six years later) to fix it, this will be a very long road. The question we must answer is simply: What type of home borrower do we want to subsidize and how do we want to provide that subsidy. Unfortunately, the answers will not come so easy.Federal Reserve Chairman may testify in a case regarding the bailout of AIG. A federal claims judge ruled Bernanke must testify as a "key decision maker" regarding the bailout. Should Bernanke's testimony play a pivotal role in determining the legality of the government's actions - as it surely will - and the verdict find the government...Read More

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